The problem is that states do not have access to all of GDP in servicing their debts. If the share of GDP states can access for debt service is declining, then MGDP will paint an overly rosy picture of the ability of states to pay.
Why might a state’s access to GDP for debt service decline? There are a number of reasons.
- Federal taxes. If these rise, the states will find their own base of taxable income declining.
- Public sector pension funds and benefits. Money that must be collected to pay for these cannot be accessed for debt service.
- Health care, housing and food. It’s unlikely that a state will be able to raise taxes if such increases would reduce the access of its citizens to such basic necessities.
- Globalization. Competition for jobs from abroad will limit the ability of states to raise the share of individual and business income they collect to service their debt.
Any realistic assessment of state finances has to take into account the fact that each of these factors is likely to grow over the next few years. Which means that the percentage of GDP available to service muni bonds will decline.
What we really need is some kind of debt service coverage ratio that will compare the unencumbered potential revenues of states to their debt service costs.
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